Stagflationary forecast masks a dovish BOE
Making sense of the latest trends in property and economics from around the globe
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A lot less growth, more inflation, higher unemployment. The Bank of England's view of the future, published alongside its decision to cut the base rate to 4.5% yesterday, looks pretty bleak.
But, if inflation is likely to rise to 3.75% over the first half of this year as policymakers expect (see chart), why the vote to cut rates? Well, there are two main reasons; firstly, energy prices will cause the upcoming spike in inflation. European natural gas futures prices have risen around 20% since the Bank's November report, which has prompted an increase in the Ofgem price cap. However, policymakers are happy that the uptick wll ebb without causing "second-round effects".
Secondly, in the unlikely event that there are knock on effects, inflationary pressures can be absorbed by an "emerging margin of slack in the economy", which is the Bank's way of saying that the economy has some unused capacity - demand for goods and services is weakening relative to the economy's ability to produce them.
A dovish vote
Still, the fact that the Bank is loosening policy as the rate of inflation rises to almost double the 2% target hints at how precarious the UK growth outlook is. There was no growth between November and March, and Bank staff reckon the economy actually shrank 0.1% in the final quarter.
Meanwhile, the economy will expand just 0.75% this year, half the Bank's November forecast. Growth will hit 1.25% in each of the next two years, down from 1.5% previously. This sluggishness is feeding through to the jobs market: more than half of 2,300 firms contacted by the Bank in January said they expected to cut staff. Almost four in ten thought they would pay lower wages due to tax rises announced in the Budget.
This helps explain why the balance of the vote was more dovish than economists had expected. Seven of the nine members of the Bank's Monetary Policy Committee voted for the 0.25 percentage point cut to 4.5%, but two wanted a bumper, 0.5 percentage point cut.
That prompted a reassessment of the Bank's likely cutting cycle. Markets now expect three more cuts before the end of the year. Analysts at firms including TS Lombard reckon the base rate will fall further to 3.5%. The FTSE 100 hit a new record. Sterling fell 0.6% to close at $1.244.
House prices
We may see a few lenders bring down mortgage rates if the outlook holds, but they will be small reductions. We'd need to see a pretty substantial shift in the outlook for rates to fall meaningfully.
Still, activity is proving pretty robust, given the levels of economic volatility. Mortgage approvals for house purchase are in-line with the months leading up to the pandemic. Meanwhile, house prices climbed 0.7% in January, Halifax said this morning. The annual growth rate is slowing, however - prices are up 3% in the past twelve months.
“Supply has risen more than demand in 2025, which should keep downwards pressure on prices in the short-term," says Knight Frank's Tom Bill. "Underpinned by a stamp duty rise in April, there have been tentative signs of stability in recent weeks, especially among needs-driven buyers in equity-rich markets where the impact of higher mortgage rates has been felt less acutely. How long that lasts depends on the bigger economic picture, including whether the UK gets caught in the crossfire of a trade war between the US and EU, how stubborn inflation proves to be and the impact of the Chancellor fast-disappearing financial headroom.”
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